To PDMA or not PDMA?

The finance minister has withdrawn the provisions in the budget related to the creation of an independent agency for managing public debt and moving the regulation of the secondary market for government debt from RBI to Sebi.

Some in the media have interpreted this as a victory for the RBI governor; others have suggested that the PMO got the finance minister to back off. I have no comments on these reports. Be it noted, however, that what is now proposed that the finance ministry will work with the RBI on the creation of a PDMA.

Former finance minister P Chidambaram has blasted both the finance minister and the RBI governor and demanded explanations from both. In an article in the Indian Express, he wrote:

RBI was among the first to recognise the conflicts of interest and, therefore, in its Annual Report 2000-01, proposed the idea of a PDMA. It was supported by the Percy Mistry Committee on Making Mumbai an International Financial Centre (2007), the Raghuram Rajan Committee on Financial Sector Reforms (2008), the Jahangir Aziz Internal Working Group on Debt Management (2008), and the Financial Sector Legislative Reforms Commission (2011). The reports of the two last named bodies also suggested a draft law to create the PDMA...

Mr Rajan is the Governor of RBI. He chaired a committee that supported the two reforms. Even a few weeks ago, he publicly backed an independent PDMA. If the RBI that he heads is now opposing the reforms — proposed through statutory changes — he is obliged to disclose the RBI’s reasons and also explain why he changed his own views. Equally, Mr Jaitley is obliged to explain why he gave in to RBI’s opposition, what is the “further consultation” with RBI expected to yield, and what is the time line for the next move on the two proposals....

Fair enough. But the question is not whether we need a PDMA. The question is whether it is needed right now. After missing the FRBM target for the fiscal deficit for several years, the government promises to meet the target in 2017-18. Until then, its borrowing needs will be substantial. And banks will have to finance the borrowing needs. That means the RBI must use the SLR weapon to mobilise funds for the government. If primary debt is independent of RBI, then the RBI cannot stipulate an SLR- as many have pointed out.

The only solid argument that people are able to make for a PDMA is that there is potential conflict of interest where the RBI is concerned- the RBI cannot set interest rates while also trying to raise debt for the government at the cheapest rate. But many ex-RBI governors have categorically stated that this conflict is only notional- it does not exist in practice.

Interestingly, opinion among former RBI top brass seems to be divided. On TV the other day, I heard D Subbarao saying he did not see a great need for an independent PDMA. It appears, however, that C Rangarajan is favour.

The sensible thing to do is to plan a PDMA properly- remember, the expertise in the area resides mostly in the RBI today. So, proper staffing and training has to be planned for before we can think of an independent agency.

The end of global banking?

With some of the biggest banks retreating from overseas markets, there is an impression that the age of global banking is over.

This isn't true. The form of global banking is changing- less cross-border flows, more lending through local affiliates. Moreover, the large international banks are being replaced in some markets by regional banks.

Regulation is the principal driver of these changes, followed by politics and shareholder pressure on large banks to perform.

More in my article in EPW, Global banking in retreat?

Seymour Hersh and the US-Pak conspiracy on Osama: a sceptical view

Seymour Hersh, the famous investigative reporter who uncovered the My Lai massacre in Viet Nam and the Abu Ghraib torture, has created another sensation with his story on the collaboration between Pakistan and America in the killing of Osama bin Laden. He says that the Pakistani generals sold Osama to the Americans.

One American site has voiced scepticism on this story, pointing to several discrepancies and shortcomings in Hersh' story. This is one story that won't go away in a hurry.

One year of Modi: the real challenge in the economy

As the Modi government completes one year in office, it has been hit by several adverse developments: a firming up of oil prices (although the price of $60 is built into the official assumptions), a decline in the nominal exchange rate (considered beneficial by many given that the real rate had strengthened), a sell-off by FIIs (following the application of MAT to their profits) and widespread agrarian distress.

But these factors should have been offset, in popular perception, by the prospect of a return to an 8% growth rate and a decline in the inflation rate. Why has this not happened? One is that people, perhaps, don't see the acceleration in growth as owing to the NDA government's policies- it's a gift from the CSO which has revised GDP growth rates upwards after moving the base year forward to 2011-12.

A second reason is that 8% growth doesn't generate enough jobs, given the economic model we are following. To make an impact on job creation, we need a growth rate of 9-10%. And that's hard to achieve when the global environment in weak, corporates are mired in debt and public sector banks lack capital. India faces what the Economic Survey calls a 'balance sheet crisis with Indian characteristics.' Such a crisis is seldom resolved in a hurry and it won't be resolved just by pushing through a set of reforms. The real challenge for the government is whether it should try to accelerate growth in such conditions or try to tweak the economic model so that growth results in better outcomes for more people.

More in my article in the newly started news and analysis portal, The Wire. 

'India's private banks will have half the share of the market in 10 years'

That's the forecast made by Rajiv Lall, chairman of IDFC which will soon become a bank.

It appears that, by private, Lall means both domestic and foreign banks. Today, their combined share is less than a quarter. One can't expect much of an increase in foreign banks' share. So, for Lall's forecast to be come true, the domestic banks must increase their share from 15% to 40%. That's a tall order considering that domestic banks managed a share of just 15% in twenty years' time. I think it's more likely that total private share would be around 40% leaving public banks still dominant but much depends on how much the government is willing to support the public sector.

There's one more thing that's worth noting. The private sector is extremely profitable precisely because it's so small- it has stayed out of financing the infrastructure sector, by and large. If private banks are to grow, they will have to lend more to key sectors such as infrastructure. Such growth will come at a price- profitability won't be as high. Shareholders must hope that private banks don't chase growth as much as Lall thinks they will.

Did UK electorate vote for austerity in polls?

The victory of the Conservative party, which surprised pollsters and shocked pundits, is on account of the significant turnaround in the UK economy brought about by the austerity policies of Chancellor George Osborne, writes Niall Ferguson the historian. He contends that, contrary to the predictions of economists such as Paul Krugman, austerity produced impressive results:

The UK had the best performing of the G7 economies last year, with a real gross domestic product growth rate of 2.6 per cent. In 2009, the last full year of Labour government, the figure was minus 4.3 per cent. Moreover, far from being in depression, the UK economy has generated more than 1.9m jobs since May 2010. UK unemployment is now 5.6 per cent, roughly half the rates in Italy and France. Weekly earnings are up by more than 8 per cent; in the private sector, the figure is above 10 per cent. Inflation is below 2 per cent and falling.....the general government deficit has been nearly halved from 10 per cent in 2009 to 5.7 per cent last year; the structural deficit more than halved from 9.8 per cent to 4.2 per cent. The net public debt has been stabilised at roughly the same level relative to GDP as that of the US.

Showing a growth rate after a decline is not a big achievement, although it's better than accentuating the decline itself. The crucial question is whether the UK is back to its pre-crisis level of GDP and how close it is to the trend rate of growth. Also, we have no means of knowing the answer the question: would Keynesian policies have produced better results?

Why cash transfers may not work for food subsidies

We have started off with cash transfers for cooking gas. Also, for pensions, maternity benefits, scholarships, etc. The big challenge is cash transfers in lieu of food subsidies. In a well-argued article in EPW, Dipa Sinha contends that this is a bad idea. It's useful to summarise her arguments because, unfortunately, those opposing cash transfers seldom lay out their arguments as well.

First, cash transfers would replace the Public Distribution System (PDS). PDS, as Sinha points out, exists both for procurement as well as distribution- it is meant to take care of both the farmer and the consumer. Cash transfers can't take care of the farmer. Sinha rightly asks what would happen to food procurement once PDS is closed down.

Secondly, the old argument about high leakages in PDS is not as strong today given that leakages have come down generally and are pretty low in many states. Experience shows that wider coverage and lower prices help reduce leakages- and that is precisely what is intended under the Food Security Act. It would indeed be an irony that the PDS were to be shut down precisely when we appear to be on the verge of effecting a significant improvement in it.

How does wider coverage help? Well, the problem with focusing only on the BPL category is that a large number who qualify get left out. Making the system universal takes care of this lot. Moreover, having two prices, one for BPL and another for APL, is what creates incentives for leakages. This may sound paradoxical but the wider the coverage, the lesser is the leakage- this is because wider coverage addresses dual pricing which is the source of the leakage.

Thirdly, despite Jan Dhan Yojana, access to the banking system is difficult. So how do the poor access the cash they need to buy food? It will take years to put in place the architecture for reliable and accessible cash transfers.

Fourthly, if PDS outlets are closed, where do people go for food? The local kirana store is not a reliable substitute and, given that store owner doubles as a money lender, it could push more of the poor into debt.

There are other advantages to having PDS that Sinha mentions: the money saved on buying cereals goes towards buying better foods such as pulses; it protects the poor from the vagaries of price fluctuations. It will be difficult to offer protection against price fluctuation with cash transfers whatever the attempt to link these to inflation.

Cash transfers for food subsidies can be contemplated once we are at a higher income level, nutrition levels have improved and poverty is less acute than it is today. Dismantling the PDS right now is fraught with huge risk.

NRN's son-in-law contesting elections in the UK

Rishi Sunak is a Tory candidate for parliament in the imminent elections in the UK. One report suggests that he's not hitting it off with the locals- and underlying racism amongst voters could be a factor.

Thanks to Siddharth Varadarajan tweet for the pointer.

Reviving public sector banks

I was on ET Now over the weekend on the subject of reviving public sector banks. Here's the link to the video.

Executive pay is an unresolved issue of governance

Here's an interesting statistic, cited in an article in the FT,  about a survey done on executive remuneration: 54% of non-executive directors polled think the executive remuneration model is broken.  I suspect the percentage in the public at large would be much higher.

What are the things that are generally perceived to be wrong?

1. CEO pay (which is a proxy for top management pay) is obscenely high in absolute terms: the average pay in the US in the top 350 companies is$15.2 mhn.

ii. CEO pay has risen much faster than the stock market or the average worker's pay. As a result, the ratio of CEO pay to average worker pay - 296:1 in the top 350 companies in the US- is unaccetably high

iii. CEOs are rewarded even if their companies haven't done well.

There are any number of explanations for the explosion in CEO pay. At one extreme, there are people who think that the increase in CEO pay reflects market forces. At the other extreme, people think that CEO pay is a reflection of poor governance and dysfunctional boards of directors.

What is to be done about high CEO pay? Again, there have been any number of solutions proposed: better disclosure, stricter and more transparent pay, shareholder say on pay, curbing or getting rid of stock options, paying CEOs only in cash and restricted stock, getting rid of variable pay altogether.

Better disclosure certainly should be a starting point. This should include disclosure on maximum to minimum pay ratios, as proposed currently in the EU. But the long-term solution is to have tighter regulatory norms and boards that are constituted very differently from today. You cannot expect 'independent' directors to be independent as long as they are beholden to management for their jobs. We need some independent directors at least to be selected independently of management- by stakeholders such as institutional shareholders, banks and employees.

Will this happen? Alas, not in the near future.

'Edward Snowden of banking'

That's the name given to Herve Falciani, the man who blew the whistle on people who allegedly used HSBC's arm in Switzerland to dodge taxes at home. Falciani gave the information to the French authorities who, in turn, have shared some of it with others. The story has been told often enough. FT has a  lunch session with the man.

Guessing game on Grexit

Not many people can predict correctly the movement of the stock market; there are plenty of people who can give explanations for a rise or fall in the index after it has happened.

The same is true, I guess, of major macroeconomic events. I have been following the twists and turns of the negotiations between the newly elected left-wing government in Greece and the triad of the EU, the ECB and the IMF. I do not have answers to three questions:

i. Will Greece default on its debt?

ii. Would such a default lead to a Greek exit or Grexit?

iii. Will a Grexit seriously impact the world economy.

The best guess I have is that the impact of a Grexit on the world economy will be greater than the European authorities think. I believe that is also the serious apprehension the Americans have, as this article in FT makes clear. The Americans should know. They didn't think the collapse of Lehman Brothers would lead a to crisis; it lead, we know, to a catastrophe. So when the president of the ECB claims that Europe has the tools to handle the fallout of a Grexit, there's reason to be sceptical.

As Martin Wolf points out in another article in the FT, the Greeks have made substantial adjustments in terms of the primary deficit, the fiscal deficit and the current account balance. There have been enormous costs in terms of reduced output and employment. Any further "reforms" must carry with them, not just the promise of the release of bail-out funds already promised by a substantial debt write-off. Very simply, any further sacrifice on the part of the Greeks must carry a substantial reward. Only such a deal can be sold to the people of Greece.

The Europeans think they can handle a Grexit. What if Greece itself is able to handle it? Will that nor provide clear incentives to Spain, Portugal and others? Will not the electorates in those countries want to do likewise?

It would be foolish to under-estimate the long-term impact on the world economy of Grexit.

Presenting Hinduism: striking a balance

Much of the discourse on Hinduism in the west tends to be biased. It is equated with Hindutva, which, in turn, is equated with right-wing Hinduism.

An NRI prof, Vamsee Juluri, has attempted to right this discourse in a recent book which is intended partly as a riposte to Wendy Doniger, whose own book on Hinduism came to be banned in India.

Rediff carries an interesting interview. Here's part one and here's part two.

Succession planning? What's that?

Outlook recently had a story on two high-profile companies, L&T and ITC, whose chairmen have hung in for longer than investors and analysts would think desirable. At L&T, AM Naik has been chairman for 12 years; at ITC, Y Deveshwar has been around for even longer-18 years. Neither is exactly young- Naik is 72 and Deveshwar 68.

Many promoter-managed companies have put in place norms for the person at the top to exit at some age. These are two professionally managed companies where succession planning has been found wanting. I refuse to buy the argument that a CEO deserves to stay on because he has performed well. Performance cannot be judged by financial results alone. One dimension on which performance needs to be measured is having a solid line of successors- and seeing how well the company performance after the CEO has exited.

What does the record of the two companies on succession planning say about corporate governance? I leave it to you to judge.

CEO cuts own pay to pay employees more!

It could be a story straight out of Ripley's Believe it or Not.

A CEO of a small company in the US has decided to cut his own pay from $1 million to $70,000 and will dip into his company's profits so that he can pay his employees more. His objective: to raise the minimum wage in his company to $70,000 over the next three years.

What's special about the figure of $70,000? Well, it turns out that upto $70,000, extra money adds to one's happiness.

To me, what's striking about the CEO's act is that it drives home a basic point about corporate pay: what those at the top earn is often at the expense of what those at the bottom earn. CEOs lobby to keep minimum wages low. They ensure that unions are kept weak. They fire workers in droves and use some of the savings to boost their own pay. They move operations to low-cost economies so that US workers lose their negotiating power.

The result is that the ratio of CEO pay to worker pay has risen from 20:1 in 1965 to 296:1 in 2013. The average CEO pay in the top 350 US companies was $15.2 mn. High CEO pay goes hand in hand with enormous inequality in pay. As the New York Times story, referenced above, notes, the SEC has been reluctant to make it mandatory for US companies to disclose the ratio the highest to lowest pay in US companies.

The story also cites Peter Drucker's norm of 20:1 for the ratio of the highest to lowest pay in a company. In India, the ratio is even higher. I wonder what the ratio is at Infosys where Vishal Sikka is paid more than Rs 30 crore. Would it be 1000:1? And this is the company where N R Narayana Murthy was not long ago talking about a ratio of 20:1 or 25:1 as an acceptable level of disparity in pay!

Are online education's prospects brightening?

Yes, it appears from a recent article in the Economist.

We have to be clear what we mean here. Online education through mass open online courses (MOOC) has caught on - in the sense of helping people educate themselves. But the nub of the issue is whether such education translates into a job, whether an online degree is saleable. So far, this hasn't happened because universities and employers are unwilling to recognise an online degree as a substitute for an on-campus or full-time degree. But this may be changing in subtle ways. Universities can use online education to supplement on-campus courses, instead of viewing it as an alternative. Then, online begins to look really attractive. Here are some models:

• Mix of online and on-campus courses: Many universities are now willing to experiment with a mix of online and on-campus courses- a notable example being the Arizona State University at Phoenix. It's using online courses to help under-prepared students with remedials, for instance. It's also using data analytics to zoom in on students who need help. This way, online can help students finish their degrees on time and help them cut the costs of college education. It also means faculty resources can be freed from certain kinds of teaching work and more students can be enrolled. ASU is able to offer a degree as a result for $10,000 for in-state applicants.
• Offering a course both on-campus and online: Students have a choice of getting credits for some courses either online or by being on campus. A degree can be done full-time or part-time.
• Taking credits online from another university: Some of the lesser universities could allow their students to take credits by doing online courses from a credible place such as Harvard.

The trick, therefore, is not to position an online degree as a substitute for a full-time degree. Market acceptability for that may be long in coming. The more sensible thing is to have a mix of online and on-campus courses. This cuts costs for students while helping universities to maintain their revenues by reaching out to larger numbers.

Online's big advantage is lower cost. Campus education's big advantage is acceptability in the market. Marrying the two is the way to make education affordable and worthwhile for more and more people.

Remaking RBI: Rushing changes is unwise

Moves are afoot to diminish the role of RBI in the financial sector. Whatever the theoretical merits of the different proposals, the government needs to hasten slowly. It's not as if financial regulation or the RBI in particular is an obstacle to growth today. There are plenty of other things the government needs to do more urgently in terms of the economic agenda - it's hard to see why remaking the RBI should be a priority at the moment.

It may be well that the political establishment, including the bureaucracy, has been upset over the years over the RBI's stand on interest rates.Some of its frustration is understandable but the solution is not to cut the RBI to size but to engage more vigorously with the RBI governor on interest rates.

More on the differences between the finance ministry and RBI in my piece here.

Manufacturing: China's loss may not be India's gain

India's manufacturing sector has disappointed in the past- it has failed to create the large number of jobs India needs. Many think that, with the right policies, India can grab a big share of manufacturing jobs out of China and into other Asian countries. This may not happen, as an article in the Economist points out.

One reason China is expected to lose is that wages in China have been rising rapidly. But China is offsetting this through use of greater automation- it has stepped up use of robots- and by massive investment in infrastructure. If productivity gains keep ahead of wage rates, Chinese manufacturing will remain competitive.

Secondly, the jobs that are moving out of China are moving into South-East Asia, which has close linkages to China. In other words, China is emerging as the centre of the Asian supply chain, with South East Asian countries on the periphery.

Thirdly, China is a big consumer of manufacturing goods, so locating production close to China reduced transport costs.

The article correctly points out that India does need to create more jobs in manufacturing. But job creation cannot happen merely by replicating the Chinese low-cost manufacturing strategy. Both services and agriculture will have to contribute to the process. As many have pointed out, India's strengths may well lie in knowledge-based manufacturing, not the light engineering that has been China's forte.

 There's one point the Economist overlooks. The revised GDP figures show that the share of manufacturing in GDP has been understated in the past. It's not 16% as thought earlier but around 25%. If these figures are to be believed, the 'challenge' of raising the share of manufacturing does not exist- it has already happened!

Global banks no longer make money

As readers of this blog would know, I have always been sceptical about size in banking. It's not that the bigger you are, the more money you make; or the more spread about you are across nations, the more money you make.

Today, three Cs- the costs of capital, compliance and complexity- overwhelm the size effect, as the world's top banks are discovering. The Economist tried to see what sort of return on equity the big global banks would make under the new Basel 3 capital requirements (they assumed equity capital requirement or core tier I equity would come to 12-12%). They stripped out one-off costs that these banks have incurred, such as fines for violation of regulations. It turns out that the best case ROE is a little above 10 percent for HSBC, 10 percent for JP Morgan Chase and below 10 percent for Stanchart, Deutsche Bank, Citigroup and BNP Paribas.

Why has global banking turned out to be unprofitable of late? The Economist offers explanations:

First, these giant firms proved hard to manage. Their subsidiaries struggled to build common IT systems, let alone establish a common culture. Synergies have been elusive and global banks’ cost-to-income ratios, bloated by the costs of being in lots of countries, have rarely been better than those of local banks...

Second, competition proved to be fiercer than expected. The banking bubble in the 2000s led second-rate firms such as Barclays, Société Générale, ABN Amro and Royal Bank of Scotland (RBS) to expand globally, eroding margins. In 2007 RBS bought ABN in a bid to rival the big network banks. It promptly went bust, proving that two dogs do not make a tiger. The global giants also lost market share in Asia to so-called “super-regional” banks, such as ANZ of Australia and DBS of Singapore. 

Bank supervisors, meanwhile, have imposed higher capital standards on global banks. Most face both the international “Basel 3” regime and a hotch-potch of local and regional regimes. A rule of thumb is that big global banks will need buffers of equity (or “core tier one capital”) equivalent to 12-13% of their risk-adjusted assets, compared to about 10% for domestic firms. National regulators increasingly demand that global banks ring-fence their local operations, limiting their ability to shift capital around the world. The cost of operating the systems that keep regulators happy is huge. HSBC’s compliance costs rose to $2.4 billion in 2014, 50% higher than the year before. JPMorgan is spending $3 billion more on controls than it did in 2011.

Compare Indian banks with these global giants and you find that we are much better placed. Private banks had an average return on equity of 16 per cent in 2013-14, SBI and its associates over 10 per cent and nationalised banks just under 8 per cent. These are under unusually stressed conditions, given the problems in infrastructure related lending. Combine these returns with credit growth of 15-20% in the next few years, with  a high retail component with low risk and high yield and you realise why Indian banks are sitting pretty. Global fund managers who believe in India should be putting their money in a big way into Indian banks.

China's Infrastructure Bank can't be thwarted

The US is miffed with the UK for agreeing to join China's proposed Asian Infrastructure Investment Bank. India too is expected to be among the 35 countries that will join.

Infrastructure in Asia needs enormous funding. The World Bank cannot meet its needs nor the ADB. The IMF/ World Bank have refused to change their governance structure in line with the changing realities of the world. China is sitting on foreign exchange reserves of $ 3.8 trillion. The AIIB is inevitable under the circumstances.

The AIIB will be dominated by China, unlike the proposed Brics Bank where all the founding shareholders will have equal votes. There's every prospect that China may reserve veto powers for itself. Still, Martin Wolf of the FT thinks the rest of the world should join- he spells out his reasons for saying so:

First, the US, Europeans and Japanese treasure a degree of influence on global financial institutions that is increasingly out of line with their position in the world. Moreover, they have failed to exercise that stewardship as well as they ought to have done. Not least, they have insisted on the right to appoint leaders who have been far from consistently excellent.

Second, it is five years since the Group of 20 leading economies agreed on new quotas that would moderate their outsized influence at the International Monetary Fund. The world is still waiting for the US Congress to ratify the changes. This is an abdication of responsibility.

Third, the world economy would benefit from larger flows of long-term capital to developing countries as well as from a bigger insurance fund than the IMF can offer to countries exposed to “sudden stops” in capital flows. 

Women on board in Germany- two cheers!

The big news on international women's day yesterday was Germany's decision to mandate 30% of board seats on listed companies for women. One report says that the move will affect 100 listed companies. That's a small number but these are the biggest names in business, so the move is indeed significant.

The move came after it's become clear that women are heavily under-represented in top Germany companies and that the only way to get these companies to change is to shove quotas for women down their throats. Germany is only following in the footsteps of other European countries. Norway, Spain, France and Iceland all have 40% board quotas for women. Italy has a one-third quota, Belgium 30% and the Netherlands and non-binding quota of 30%. Interestingly, the UK does not have such quotas.

Gender diversity is, of course, necessary and useful. I happen to think that, by pushing gender diversity, we will be able to get diversity of other kinds- class, ethnic and professional diversity. Why? Because, it will be difficult to fill the positions with women with only a certain background or class- say, high income, corporate types. Companies will be forced to cast their nets wider and, in the process, will have to break out of the closed club from which board members now come. They will have to look for women with varying backgrounds.

How does diversity help? Well, it's established that diversity of viewpoints contributes to better decisions. Boards need this badly because today they happen to suffer from group think. It's interesting that a study , done by MSCI, has found that companies with more women on the board are less likely to be hit by scandals. As one asset manager correctly points out, this has less to do with women per se than with women bringing in diversity, a different way of looking at things:

I don’t think this is because women are inherently more ‘moral’ than men. And it’s difficult to tease out cause and effect — are better companies more likely to embrace diversity or does diverse leadership make for better companies?
What we can say with certainty is that gender diversity is a good proxy for more general cognitive diversity, and we know that cognitive diversity leads to better problem solving and outcomes.

This would be the argument for pushing for such quotas in India as well. It's shameful that companies are huffing and puffing to fill the one seat mandated for women under clause 49. Even more shameful that promoters have chosen to fill the sit by appointing their wives, mothers and daughters on to the board. This is not genuine diversity at all.

I know the I run the risk of getting lynched but I would argue for quotas for SCs/STs and OBCs as well on boards- and for the same reason, namely, that it brings in more diversity. It will also go a long way towards making companies more tuned to the bottom of the pyramid if somebody from that segment is on the board. So, you see, boardroom diversity is not about affirmative action or correcting wrongs in society. It is simply about making boards more effective.

Setting quotas is one way of getting diversity but this will be fought and resisted. Another way is to introduce proportional representation boards- allowing all stakeholders, not just the promoter or dominant shareholder, to select board members. Today's boards are stuffy, boring places where there's no genuine debate or active questioning. We need to shake them up. Setting quotas and introducing proportional representation will make boards and companies more vibrant. 

Goodbye big bang reforms, hello economic growth

One of the most striking points of this year's Economic Survey relates to 'big bang reforms'. For years, commentators have been bemoaning the lack of political will to push through such reforms. IN the run-up to the budget, they have been warning the government that it will be judged on how well it does on this account. The Survey pours cold water on such hopes and explains why:

Given the expectations surrounding the upcoming budget, one question needs to be addressed head-on: Does India need Big Bang reforms?Much of the cross-country evidence of the post-war years suggests that Big Bang reforms occur during or in the aftermath of major crises. Moreover, Big Bang reforms in robust democracies with multiple actors and institutions with the power to do, undo, and block, are the exception rather than the rule.India today is not in crisis, and decision-making authority is vibrantly and frustratingly diffuse.

This is refreshingly candid stuff- and one hopes it will put an end to the 'big bang reform' cottage industry. It's not just that such reforms are not politically feasible. One could argue that the past pace of reform is perfectly consistent with rapid economic growth in India. Over ten years of the UPA regime, few major reforms occurred- and we saw among a period of the highest growth ever.  In the slow growth period of the last three years when the world was still feeling the impact of the financial crisis, India grew at 6.7%. The Indian economy is now set to grow at over 8% in 2015-16. We should not be surprised. Reform or no reform, we can expect an investment rate of 32% or more. This should translate into growth of around 8%.

The Survey should have spelt out the implications for fiscal policy of  the imminent return to the high growth path. Whenever the economy is growing at over 7% and 8%, the fiscal deficit problem tends to disappear- the fiscal deficit to gdp begins to decline and fall within an acceptable range. The debt to gdp ratio also declines. If we are looking at double digit growth in the medium term, we can tolerate a fiscal deficit to gdp ratio of over 3%. The finance minister need not have been apologetic at all about deferring the year for meeting this target by one year, as he has in the budget. He might have been bolder on the spending front and given a greater boost to public investment than he has.

More on the growth and India's fiscal problem in my article here.

Raghuram Rajan on free markets and political freedom

Rajan's most recent speech on democracy, inclusion and prosperity has drawn attention for quite the wrong reason: the reference to Hitler and the perils of strong government. Since Modi was being likened by the Congress to Hitler in the run-up to the last elections, the reference is liable to be misconstrued and, indeed, the highlighting of this particular point in sections of the media appears mischevous.

It's the larger point in the speech that deserves highlighting, namely, that liberal democracies rest not just on three pillars- rule of long, strong government and political accountability- as Francis Fukuyama has said but also on a fourth one, free markets.

Rajan sees competition in the market place as the counterpart of competition in politics. The two tend to support each other. However, he points out, there is a difference. In politics, every citizen has one vote. In the marketplace, the richer guy has more votes than the poorer guy. He then poses the question: why would voters not use the power of their votes to disenfranchise the rich? Because they see the owners of property or resources as spreading prosperity and benefiting the voters. Also, they don't mind richness as they long as they see a certain fairness about the acquisition of wealth. As long as these two conditions are met, voters will tolerate free markets and a measure of
inequality.

Well, well, the conclusions appear rather sweeping. It's not as if voters can disenfranchise the rich if they wanted to. The people who get voted in do support with the money power of the rich behind them. They are beholden as much to the rich as to the voters. And their natural affinity is towards the rich rather than the voters.

As for the fairness of the process, we do know that upward mobility has fallen in the US. And, we have one book (The son also rises) that claims that mobility has changed very little in the west over hundreds of years. In India, upward mobility has been made possible more by the political process rather than the markets. By grabbing political power, the backward classes and the scheduled castes have been able to advance. They have also advanced through government jobs. Markets and enterprise haven't contributed as much.

There isn't much fairness or legitimacy to the system we have. Political accountability has largely meant substituting one set of crooks supported by businessmen with another set of crooks supported by businessmen. The victory of Aap in the Delhi polls shows that people are still looking for a fix to the crooked political and economic system we have. A Nandan Nilekani emerging on the landscape doesn't mean much of a change in the Indian system. Inequality is more of an issue, perhaps, in Indian than in the US where it has emerged as an important issue.

In the long term, genuine democracy or political freedom does not seem compatible with deep inequality. How to get the political system to address such inequality will remain the fundamental challenge in the years to come.

Government mustn't get fixated on the fiscal deficit.

Should the government stick to its fiscal road-map- 4.% for fiscal deficit/GDP in the current year and a lower deficit the next year? Ruchir Sharma argues in today's TOI that it should. He gives instances, such as China, where an increase in government spending has been followed by lower growth rate.

I disagree. China is over-invested in infrastructure. We are under-invested. Without infrastructure investment, it's hard to see investment in general reviving. And the private sector is in no position to get into infrastructure now. So, the government should go ahead and spend on infrastructure- and it doesn't matter if it's about half a percentage point away from its fiscal deficit targets. Here's my case.

India's debt to GDP ratio of around 65% today is among the lowest in the world today. So, considerations of sustainability of debt need not deter us. The only case can be that higher spending will spur inflation which will undermine our currency. The inflation rate has declined sharply, our external account has improved considerably and quantitative easing in Europe and Japan can be expected to offset somewhat the effect of any rise in the interest rate in the US. So, concerns about the impact of the rupee are not a factor either.

Whichever you look at it, this is the right time for Jaitley to go out and spend boldly.

The many mistakes of Narendra Modi

Vox Populi is Vox Dei. The voice of the people is the voice of God. Whatever  your political leanings, it's hard not feel a sense of exhilaration over the outcome of the Delhi elections.The people have spoken- and how!

It's not just a vote for Kejriwal & Co. It's a vote against the NDA government. It's an expression of anger against the Modi and the BJP. That alone can explain the margin of victory of Aap.

How has this come about? Why are the voters of Delhi so angry? Let me list what I think are some of the mistakes Modi has made. Some of these points may have been made by others but I'd like to add my own little voice:

i. Choosing Kiran Bedi over the heads of long-serving leaders of the Delhi BJP: Harsh Vardhan, now a minister in Modi's cabinet, was a five-time MLA. He's known for his probity. He was discarded in favour of an outsider. Moreover, an outsider who had been baiting politicians, including Modi, until very recently. This angered not just BJP workers but the electorate. What was on display was the politics of opportunism.

ii. The Land Acquisition ordinance: This allows the government to grab people's land without their consent. The slum-dwellers of Delhi must  have reckoned that, if the government could grab land that poor people owned, they wouldn't think very hard about uprooting poor people who were sitting on land they didn't own (whatever the poll promises of the BJP).

iii. Proximity to industrial houses: We've had so many functions where the leaders of industrial houses, some of whom are close to the BJP, have showed up. It's not a good for politicians in India to advertise their proximity to industrial houses. The BJP came to perceived as the wrong AAP- Ambani and Adani Party.

iv. Making a huge spectacle of the Obama visit:Ok, you wanted to get the US president over. But was it necessary to make such a spectacle out of it? There's a difference between being comfortable with world leaders and grandstanding.

v. Flaunting the Rs 10 lakh suit: Especially on the social media, the impact of the monogrammed suit was hugely negative. People had voted in Modi because they identified with and admired his chaiwallah background. What they saw in the suit was somebody very different, a member of the Delhi elite.

Modi rode to power on the strength of the perception that he was an outsider who would bring to the capital a very different style of leadership, one that resonated with the aspirations of the aam admi. In his nine months in power, Modi began to look like any other member of the Delhi Durbar. This was disappointing. That disappointment has made its felt.

It's a setback but not the end of the road. Modi is a seasoned leader, somebody with the capacity to learn from mistakes. He must go back to being his original self, a leader with a natural empathy for the section of society from where he comes. And he has to make adaptations to the economic model he followed in Gujarat. He must not forget that, at least in the immediate future, the only economics that will work is one that is resolutely people-oriented- and seen to be so.

Management: awaiting the new paradigm

We have heard a great deal about the shift from the top-down model to a more decentralised one, the dismantling of hierarchy and the importance of self-driven teams. But very little of this is happening on the ground, as a report in the FT highlights. The astonishing thing is that the old, centralised model persists in the corporate world despite evidence that it's not producing results:

Returns are diminishing, while the number of listed companies has shrunk by more than half in 15 years. In that sense the fears seem justified: despite bulging coffers, quoted companies are investing too little and distributing too much in dividends and share buybacks to survive in the long term, let alone create the new products, markets and jobs economies require for sustainable growth.

What could be the reason? One is, of course, inertia and the power of the unknown. The other is that companies apparently don't know how to put in place the measures needed to make the team-driven model happen. The second is rubbish.There are plenty of models available on the new paradigm. It simply doesn't suit top management to make the shift. People at the top are concerned only about how to make their pile in the five or six years they are at the helm.They lack the motivation to worry about the long-term future of their companies.

What make bring about change? Not investor pressure because most investors too are focused only on the short-term. Real change can come about only from the NextGen crowd. Younger people don't want to be ordered around, they want challenge and fulfilment in their jobs and they need a sense of purpose. They will gravitate towards companies that provide these. Some of it is already happening. When more of the older model companies find they are losing their ability to perform, we can expect to see the present model of management being dismantled.

India set to overtake China?

Optimism about the Indian economy is alive despite 2014-15 being largely washed out. We have commentators again talking of India overtaking China in the second half of the decade. They were saying so at the beginning of the decade as well. At that time, however, China was growing at over 8 per cent. What commentators meant then was that India would inch towards 9 or 10 per cent and thus overtake China.

Today, the overtaking, if it happens, will be at a different level. And it will happen later than commentators had predicted. Chinese growth is poised to fall below 7 per cent. The World Bank sees the Indian economy growing at 7 per cent - in 2017, a good two years later than forecast at the beginning of the decade.

Still, becoming the fastest growing economy in the world is no mean prize. Is the prize within reach? Most commentators would say - yes, if the government could push through "big ticket reforms". An article in today's FT makes this point:

Reforms aimed at boosting manufacturing or encouraging capital investment may prove tougher to implement at national level than they did when he was running Gujarat. Besides, some reforms, such as relaxing the rules on foreign ownership of insurance companies, may not prove to be the magic bullets that industry lobbyists claim. Second, and perhaps more fundamental, democratic India is still caught in an ideological battle over where to strike the balance between pursuit of growth and protection of the environment and land rights.  

This is the sort of thing we have been hearing for two decades now. Reforms didn't happen in UPA-I and growth soared to 9 per cent for at least a three year period, thanks to the global boom. I don't believe India's growth is contingent on the familiar set of "reforms". I think the Indian economy can hit 7 per cent if two things happen. First, banks need to be recapitalised. This, as readers of this blog would know by now, doesn't mean "big ticket" reforms in banking. It means a few simple things like reducing the government's stake to say, 52%, getting the right people into top management, strengthening boards and improving risk management.

Secondly, the world economy needs to get better. Will it be by 2017? All bets are off at the moment. But if the improvement did happen in the world economy, we have a good chance of being the fastest growing economy in the world in 2017.

Kotak- Ing Bank Vysya merger

Shareholders have reportedly approved the Ing Bank Vysya merger. Ing Vysya Bank unions are still seeking assurance that no jobs will be lost.

There are important lessons to be drawn from the merger. One, new private banks, not foreign banks, are the big winners in the post-reform period. Public sector bank share will continue to decline but the loss will be to new private banks, not so much to foreign banks. Two, branches are crucial to cost competitiveness and growth in Indian banking- no new private bank would like less than a 1000 branches. Thirdly, for public sector banks, the branch network needs to be larger as they must rely mainly in interest income to grow profit- their ability to generate fee income is not as good as that of private banks.

It follows that PSBs with less than, say, 2000 branches are vulnerable. We are better off selling of such PSBs instead of merging them with other PSBs- mergers in today's context will weaken stronger banks. More in my EPW article, Merger they wrote.

Gyan Sangam

I return to my blog after a long lay-off, thanks to a rather hectic schedule. I'm hoping I will be more regular in the New Year and hoping also that this does not go the way of most New Year resolutions.

Well, I was over in Pune for the Gyan Sangam, a conclave of bankers organised by the finance ministry. I was there as an external expert on one of the six working groups. McKinsey was the 'knowledge partner' for the event. They made a presentation to kick off the proceedings and there was a director who coordinated our group's discussions.

We met at around 4:00 pm and carried on till nearly 8:30 pm. After a break for dinner, the bankers in our group re-assembled to arrive at a consensus on the recommendations. This went on for another two hours. So, you see, this was not the usual talk shop.

Indeed, I was pleasantly surprised at how constructive and intense the discussions were. My group dealt with Risk Profiling and Recovery. After a few rounds of discussions, we were asked to put down on a sheet of paper actions that we wanted of bankers and actions we wanted of policy makers. The final recommendations emerged from the points written on these sheets. Even if a few of our recommendations get implemented, I believe they would make a sea change to risk management in public sector banks.

That said, I am awaiting clarity from the government on a couple of issues. First, does the government wish to retain the " public sector character" of banks (that is, a stake of 51 per cent or more) as the FM promised in his budget last year? Two, does the government expect PSBs to perform a social role or is it happy for them to pursue profit?

The second point is especially important as there was a lot of talk at the Sangam on the gap in performance that had opened up between private banks and PSBs. If PSBs could steer clear of, say, infrastructure and SMEs, the gap would begin to close. But will the government allow it? I doubt very much. In his speech, the PM exhorted banks to shun lazy banking and take more risks in lending. That doesn't sound like a focus on profit alone.

Leaving aside the details on a host of matters including risk management, the government needs to do two things: fix management and fix governance. Fixing management means getting the right people at the top through a rigorous selection process. It's a scandal that this has been neglected for decades now. One CMD mentioned at the meeting that his interview had last all of 12 minutes. It took a 12 minute interview to put a man in charge of some Rs 500,000 crore worth of assets. It's not just the politicians and bureaucrats who are to blame but also the RBI. The RBI governor is represented on the committee to appoint CMDs and EDs of PSBs.

We also need to end the game of musical chairs at PSBs. An ED at a middle size or big bank hops on to a small bank as CMD. He whiles away a couple of years with his eyes focused on a CMD position at a bigger bank. From Indian Overseas Bank, he might leap across to Bank of Baroda. What commitment can we expect of EDs and CMDs who don't expect to be in their jobs for more than a couple of years? What risk management is possible in such a dispensation? Enough of this. If the government is serious, it must insist on succession planning from within for the posts of ED and CMD except in rare cases. It's hard to see how a CMD can deliver performance without having gained an understanding of the culture, systems and processes of  bank over a period of time.

The next thing to do is to fix governance. The government's idea is to split the post of chairman and MD. This has the potential to create two power centres in a PSB. The chairman will exercise power without having any responsibility. The MD will have to get things done with a chairman who may engage in back-seat driving. We have to see how this goes- I have my doubts.

It's true the CMD is all-powerful in the present scheme of things. But the answer is not to split the post but to strengthen the boards with independent directors and also with well-training government and RBI directors. We need a proper selection process for independent directors- perhaps, these appointments are best done by an independent Appointments Committee.

The RBI needs to do its best for both management and governance. It must specify fixed terms for the CMD. And it must lay down stringent 'fit and proper' criteria for independent directors with the right to reject nominations that fail to meet these criteria.

I don't see thinking along these lines. At the Gyan Sangam, there was much talk about a Bank Investment Company, a holding company for all PSBs which was proposed by the P J Nayak committee. Such a holding company would be the ultimate nightmare. It would be unwise to entrust the entire set of 26 PSBs to any set of professionals, however eminent.

The government needs to make up its mind on PSB autonomy. If it wants PSBs to run autonomously, it can ensure that within the existing framework. By the same token, setting up a holding company does not ensure autonomy. Alas, there is no set of professionals, however eminent, that is not amenable to government influence. That's the reality of India today.

Satyam case judgement and independent directors

I had a post yesterday on the judgement in the Satyam case in a trial court in Hyderabad. I said it was not clear from media reports what the independent directors were fined for and why Krishna Palepu of HBS was fined Rs 2.66 crore while the other independent directors were fined Rs 20,000 each.

I am still waiting to get my hands on the court judgement. In the meantime, we have a report in BS that sheds some light on the matter:

The court on Monday imposed a fine of Rs 2.6 crore on Palepu for conflict of interest in providing professional services to the company and  remaining on the board of Satyam as an independent director and for failing to get the government's nod for providing professional services. Palepu has to pay the fine within two months.....Palepu was fined by the court as he had received Rs 87 lakh from Satyam towards consultancy fees, while each individual director was paid around Rs 13 lakh for the year 2007, according to Satyam’s annual report.

If the report is correct and the reason for Palepu's attracting a heavier fine is that he helped himself to a consulting fee as independent director, I must say the judgement is very interesting indeed. What the court is saying is that when you get paid by a company for something other than your work as independent director on the board, it creates a conflict of interest. It compromises your independence. And if that is what the court is implying, it has hit the nail on the head.

An independent director is defined as somebody who has not had a pecuniary relationship with the company for a certain number of years before he gets on to the board. Given this definition, it beats me how you can have a pecuniary relationship with the company after you get on to the board. You can collect your fee and commission but not anything else. And yet here we have Palepu, who is said to be a expert on corporate governance, providing consultancy services to Satyam and making a tidy pile. In my view, it was incumbent on other independent directors to have objected to this arrangement if they were aware of it. And the markets regulator, SEBI, should have been alert to such goings-on in companies (as I mention further on, I did raise an alarm at SEBI).

This is a matter that has troubled me for years. How can a so-called independent director earn consulting fee from a company whose board he is sitting on? I happened to be a member of the Primary Markets Advisory Committee of SEBI a few years ago. Deepak Parekh was the Chairman. When we were discussing the issue of corporate governance, I brought up this matter. I argued that we could not allow independent directors to compromise themselves in this way. I asked that SEBI write to listed companies and ask for details of consultancy fee paid to independent directors. Such companies and their directors, I said, needed to be named and shamed.

To my astonishment, my point was brushed aside. It was not even considered fit for further discussion. I heard people say that the sums involved were small, so what was the fuss about? Well, if the sums involved are small, then the independent directors should not been charging them in the first place!

I guess the Satyam judgement- again, going by the BS report- is another instance of the court having to step in where there is an executive or regulatory failure. I hope SEBI wakes up now and does what I asked them to do- collect details of consultancy fee paid to independent directors. After that, it should do two things. One, pass strictures against or issue warnings to the companies and directors concerned. Two, amend clause 49 to make it abundantly clear that independent directors are not supposed to milking the companies whose boards they sit on for personal gain.

Satyam case judgement

The judgement in the Satyam case has been poorly reported in the media. Two things are noteworthy.

First, the judgement in a trial court in Hyderabad relates to six relatively minor offences for which charges had been brought by the Serious Fraud Investigation Office. The  main trial is going on in a CBI court and the judgement in that trial is expected towards the end of the month. The fact that B Ramalinga Raju got six months in jail in the trial court should not give the impression yet that he's getting off lightly in the case.

Secondly, the independent directors haven't been let off . HBS prof Krishna Palepu has been fined Rs 2.66 crore. The other independent directors have all been fined Rs 20,000. Unfortunately, the papers don't tell us what the fine is for and why Palepu has attracted such a big fine.

The BS report suggests that Palepu was paid professional charges without obtaining the opinion from the central government. Does this pertain to the consulting fee that was paid to him? It's not clear.

But the message for independent directors is an ominous one. It has often been contended that the independent directors on the Satyam board could not have possibly known about the accounting fraud. Nevertheless, the court has imposed a fine. 

Shareholder activism in India- a new dawn?

Finally, finally, is something changing in the realm of corporate governance in India? I'm seeming a glimmer of hope.

Three things seem to have made a difference. One, allowing shareholders to vote electronically. This has empowered shareholders who could not be troubled to attend the AGM especially if it happened to be in another city.

Secondly, the recent amendments to clause 49 requiring that related party transactions be approved by 75% of minority shareholders.

Thirdly, domestic institutional investors beginning to flex their muscles.

Shareholder activism has produced some interesting results in recent months:

• The rejection of the compensation hike proposed for top management of Tata Motors despite the company making a loss
• United Spirits management proposal to sell and distribute spirits of its parent Diageo was rejected 
• Maruti Suzuki is having to bring to vote its proposal to set up a manufacturing plant in Gujarat under the auspices of its parent 

Note that RPTs also need to be screened and approved by the Audit Committee. That may not make a big difference given that independent directors are chosen by the promoters. Indeed, not much can be expected of the board in India, given that independent directors are beholden for their appointment to management or the promoter. It is inconceivable that the board can ask for the removal of the chairman or the CEO as these posts are filled by the promoter or they are appointees of the promoter.

But shareholder activism, abetted by the three advisory services that have come into being, could make up for lapses of the board. This seems to run counter to the trend in the US and elsewhere. In those places, shareholders have been stymied by various regulatory hurdles. It is boards that have begun to be more active compared to the best.

We must be careful, however, not to overdo the celebration. Shareholder activism in India can prevent expropriation of minority shareholders.  However, it is not still not in a position to discipline non-performing management.

See this story in the FT.

Wanna boost the economy? Go for infrastructure spend

The IMF is now telling us that public spending on infrastructure can provide a great stimulus to the economy- and in the developed world as much as the developing world.

 Larry Summers comments on the IMF findings:

Consider a hypothetical investment in a new highway financed entirely with debt. Assume – counterfactually and conservatively – that the process of building the highway provides no stimulative benefit. Further assume that the investment earns only a 6 per cent real return, also a very conservative assumption given widely accepted estimates of the benefits of public investment. Then, annual tax collections adjusted for inflation would increase by 1.5 per cent of the amount invested, since the government claims about 25 cents out of every additional dollar of income. Real interest costs, that is interest costs less inflation, are below 1 per cent in the US and much of the industrialised world over horizons of up to 30 years. So infrastructure investment actually makes it possible to reduce burdens on future generations.

In fact, this calculation understates the positive budgetary impact of well-designed infrastructure investment, as the IMF recognised. It neglects the tax revenue that comes from the stimulative benefit of putting people to work constructing infrastructure, as well as the possible long-run benefits that come from combating recession. It neglects the reality that deferring infrastructure renewal places a burden on future generations just as surely as does government borrowing.

It ignores the fact that by increasing the economy’s capacity, infrastructure investment increases the ability to handle any given level of debt. Critically, it takes no account of the fact that in many cases government can catalyse a dollar of infrastructure investment at a cost of much less than a dollar by providing a tranche of equity financing, a tax subsidy or a loan guarantee.

Spending on infrastructure thus involves an increase in government spending and an increase in the ratio of public debt to gdp at the beginning of the period but translates into a reduced debt to gdp ratio at the end of the period.

When this is so obvious, it has never been clear to me why in India the government has been leery of a sharp increase in infrastructure spending- and I am not referring to the recent period where concerns about inflation have come to dominate the debate.

How should companies and their bosses deal with social media?

Microsoft boss Satya Nadella learnt recentlythat just one faux pas can cause serious damage. His comment on women counting on karma to take care of their pay raise raised an enormous storm on the social media that only just settled after he apologised.

Of course, it's important for companies and their bosses to be careful. But slip-ups on the part of bosses is just one hazard that companies face in the social media. They have to face damaging disclosures, strong criticism and lethal photographs. Schumpeter points out that while anti-corporate types have made the most of social media, companies have been slow to adapt. He cites two reasons from a recent book on the subject:

The first is the nature of the internet. It is a beast that feeds on scandal and particularly delights in the flesh of the powerful and privileged. The media world used to be policed by editors who demanded proof in the form of two sources. Now amateurs can post anything they want online (though they may eventually face prosecution) and editors are subject to the tyranny of the click: the more the stories they publish are clicked on by readers, the longer they are likely to survive in their jobs.

......The second is the nature of companies. They are designed to stay in business rather than to be good at defending their bosses from scandal. No matter what PR resources they throw at killing a story, NGOs and prosecutors will always have more stamina. In America no sensible firm will risk gambling on a jury trial when a negative verdict could bar them from doing business with the government.....No sensible company will go to the mat to protect an embattled boss when there are plenty of replacements waiting in the wings. 

The book has useful tips:

 He tells CEOs to restrict the view into their glass houses: to cover the cameras on their phones and computers with masking tape; avoid the “reply all” function on their e-mail; think twice before sending any strongly worded message. He dismisses the idea that corporate social responsibility (CSR) bestows on firms the PR equivalent of a stock of political capital: digital vigilantes will always assume businesses are guilty and can add the charge of hypocrisy to CSR-obsessed ones, as they did to BP after its spill. He warns against one-size-fits-all approaches to crises: the common prescription to come clean quickly and fully sometimes stokes the fire, he notes.

Both the author and Schumpeter are, in my view, mistaken in seeing the social media entirely as some ugly ogre against whom companies must erect defences. Leaving aside scandals, keeping taps on the social media can help companies in several ways. They can identify typical customer complaints, they can get an idea of how they are viewed by ordinary people, they can see how they stack up against competition, they can identify unmet customer needs and they can get useful ideas for re-designing products or coming up with new ones.They can also the social media to convey the company's viewpoint on particular issues or to respond to negative perceptions.

Service-oriented businesses such as banks have been quick to latch on to the potential of scouring the media. Other businesses can learn too. It would be a good idea to pick somebody who understands the company's key businesses well and appoint him or her Head of Social Media. Getting such a person to interact with top management, the PR dept and the marketing heads could turn to be a good investment for companies.

B-schools: the dethroning of the financial sector

Financial firms, such as banks and investment banks, are out; consulting dominates and high-tech firms are in. This trend, which started post the financial crisis of 2007, now stands confirmed, going by two reports, one in the Economist and another in the FT. 

Mr Lewis charted the ascent into investment banking of the most talented graduates in the 1980s, a situation that still held true as the financial crisis struck in 2007. Then, 44% of Harvard’s MBAs landed a job in finance; 12% became investment bankers. Yet in the class of 2013 only 27% chose finance and a meagre 5% became members of Mr Lewis’s master race.
The trend is the same at other elite business schools. In 2007, 46% of London Business School’s MBA graduates got a job in financial services; in 2013 just 28% did, with investment banking taking a lower share even of that diminished figure. At the University of Chicago’s Booth School of Business, the percentage of students going for jobs in investment banking has fallen from 30% in 2007 to 16% this year.

What are the reasons for these trends? One, of course, is that pay in banking is no longer as attractive as before. Earlier, you put in long hours in the hope that you could quickly cash out and enjoy life. Now, this seems less possible. But there are other reasons.

Investment banks expect long-term loyalty. Consultants are happy to see people leave after five years or so- and give them business from the other side of the table. Moreover, consulting opens up a variety of opportunities whereas in banking, you are stuck in one sector.

Thirdly, there is an odour of disrepute about banks now. What young graduates hear about these places and the adverse publicity they attract because of their tangles with regulators does little for their reputation.

Fourthly, consulting firms and tech firms are seen as good training grounds for those wanting to become entrepreneurs. The tech firms' casual culture is appealing. And they too promise big bucks:

Tech firms and consultants both appeal to the growing number of students who want to gain the right experience to start their own business. A survey by the Graduate Management Admission Council, an association of business schools, found that although only 4% of MBAs have entrepreneurial experience when they enter their course, 26% say they want to start companies after they graduate.

How are banks responding? In several ways. By targeting undergrads instead of grads, by using social media and competition games to attract candidates, encouraging a better work-life balance, etc. Some are even heroically attempting an image make over:

Some are running campaigns urging graduates not to believe media stories portraying them as greedy or evil. Others are trying to lure recruits by persuading them they will help make the world a better place. Goldman Sachs’s job portal advertises opportunities to work on community projects alongside positions for analysts: “That’s why you come and work at Goldman Sachs, because you can make a difference in the world,” trills its recruitment video.
A few banks are trying to change their culture, taking a tougher line on sexual harassment of female staff and advocating a healthier work-life balance, perhaps even allowing the odd work-free Saturday. For the business schools’ brightest and best, though, all this may not be enough.

A contrarian view on Sachin Tendular

An Australian commentator launches a scathing attack on Sachin Tendular following the publication of his memoirs recently. (I must thank Rediff.com for the pointer). He writes:

With a sweet, handsome face and smile that would melt a concrete slab, he always looked more lamb than lion as a man despite his great batting feats.

Align that to his boyish, high-pitched voice that always sounded so inoffensive and the fact that he barely expressed a strong opinion about any cricket matter in his 25-year career you might have Sachin neatly categorised as the choir boy who wandered on to a cricket field and decided to stay.

But when his autobiography was released worldwide on Thursday the choir boy ripped open his robes and pulled a loaded gun from a holster.

I am not in any way endorsing the commentator's views- my interest in cricket is pretty mild these days. Just highlighting a different viewpoint. 

MNREGA must be reformed, not scrapped.

The government wants to limit MNREGA to the 200 most backward districts; Bhagwati and Panagariya suggest that, perhaps, such schemes are best scrapped. The more sensible view, which Mihir Shah puts forward, is that MNREGA needs to be reformed and made more effective.

Bhagwati and Panagariya bring up the familiar argument about leakages and corruption in government schemes. They suggest that Rs 50 reaches the worker in wages out of an estimated Rs 250 of expenditure incurred by the government. Are we not better off, they say, in simply giving Rs 50 to the poor by way of cash transfers?

There are several flaws in this argument. Let me mention two. The first is their contention that, in opting for work under MNREGA, the worker forgoes alternative income. The economists assume this income forgone is Rs 80. They assume MNREGA wages to be Rs 130 (not always the case). Hence, a net transfer of Rs 50. Now, this is simply not true. The data suggests that most MNREGA employment is of the off-season variety, that is, people queue up for MNREGA work only when they do not have other avenues of work and income.

The other flaw in the argument is that the amount spent (which the authors estimate at Rs 250 after factoring in leakages of 25%) is current expenditure because no assets are created anywhere. This, again, is not true. The experience varies across states. In some places, empirical research shows assets of good quality have been created.

The answer, therefore, is not scrapping MNREGA and replacing it with cash transfer. It is making it more efficient- that is, reducing leakages and ensuring that asset creation happens everywhere and not just in select areas. How do we do this? One starting point surely is studying the success stories and the factors that make for success. Mihir Shah writes:

The best way to do so is to study where the programme has been able to deliver. I have in mind the thousands of villages where water harvesting structures have been created, agriculture has improved, nearly 100 days of work has been provided, distress migration has reduced and women have been empowered. MGNREGA is one programme where all this has been rigorously documented by scholars from all over the world. This research also throws up insights on the features that characterise locations where success has become possible: one, availability of strong technical support to the main implementing agency, the gram panchayat; two, capacities to undertake decentralised planning exercises and creation of a robust shelf of works; three, awareness among MGNREGA work-seekers of their entitlements and procedures under the programme; four, active and vibrant gram sabhas, which debate and decide the works to be undertaken and all procedures related to the programme; five, open and effective social audits that check corruption; six, accountable gram panchayats, where the leadership responds to the legitimate demands and grievances of the people; and seven, a system that ensures timely payment of wages.

Shah supports the NDA government's plan to focus on 2500 most backward sub-districts but warns that this should not be mean denying work to those seeking employment elsewhere. That, he points out, undermines the basic principle of MNREGA which is to guarantee work to all.

And, of course, we need flexibility - in respect of what schemes to finance and also the ratio of 60:40 for wages to materials. Perhaps, the ratio need not apply to every single scheme but may be applied at a district or block level. Perhaps in some areas, a different ratio needs to be worked, depending on whether more materials are needed or more labour is needed.

Replacing MNREGA with cash transfers is quite the wrong way to go. First, there remains the problem of identifying the needy (whereas MNREGA's great strength is self-selection by those in need). Then, we need to wait for bank accounts to spread and be seeded with Aadhar, a process that will take time and that must be tested before we start using it.

Moreover, cash transfers will perpetuate precisely what the Modi government is against, namely, a dole culture. Even the poor like gainful work, the respect that goes with it and the satisfaction of having created something worthwhile. Bhagwati and Pangariya forget that MNREGA was passed by parliament and has the support of all political parties. If they thought that Modi was pro-market and would be impressed by their proposal, they may well be proved to have been sorely mistaken.

Are limits on free ATM transactions justified?

Banks will be free from today onwards to charge Rs 20 per ATM transaction once the number of transactions exceeds five per month. They will also be allowed to charge for more than three non-home transactions (that is, transactions through ATMs other than those of the bank of which one is a customer). See this news report.

Mind you, the norms don't make it mandatory for banks to charge for excess ATM use. They are free not to charge for over five transactions and they can set a higher free limit as well.

The rationale for levying charges on home and non-home transactions is that there is a cost involved for banks. If banks do not recover the cost of ATM transactions, they will recover it elsewhere. When charges are related to ATM use, then the more frequent users and people with more use for cash are penalised. When a general fee is imposed on all customers, the less frequent users of ATMs end up subsidising more frequent (and, possibly, richer) users.

The argument sounds plausible but it is somewhat flawed. First, ATMs are a means to move customers away from branches into a less expensive channel. The cost per transaction in a branch is much higher than in an ATM. So, banks save on costs by getting customers to use ATMs. This saving is large enough to cover frequent use of ATMs. Hence, the question of recovering the cost of ATM use should not arise. Indeed, banks may find that charging for ATM use is not in their interest as it may drive customers bank into branches.

Secondly, it is important to ascertain which are banks are complaining about the cost of ATM use. Are public sector banks complaining or are the complaints coming mostly from private sector banks? If the latter, the chances are that charging for ATM use is simply another way to augment revenues through fee charges which is a favourite ploy of private sector banks. (Indiscriminate and often hidden charges for various services are one reason for higher fee income at private banks and hence for higher profitability. By their very orientation, public sector banks do not follow this practice- and we criticise them for not matching private sector performance!). If it is the case that it is mostly private banks that want to levy charges for ATM transactions, then it is best that the RBI withdraws its guideline. Private banks make sufficient profit without having to levy an extra charge for ATM use.

Thirdly, charging for ATM use may come in the way of financial inclusion unless ATM use is made completely free for financial inclusion customers. If inclusion is to be pursued using technology and by avoiding costly branches, then it is important that transactions through channels other than branches not invite penal charges.

Is China's political system an obstacle to its rise?

There is one refrain that is comment to forecasts on China: the Chinese political system is incompatible with growing standards of living. There is a corollary to this: as soon as China's growth rate slows perceptibly, the strains on the political system will begin to show. Turbulence will set in. Some even forecast that the Chinese system will implode.

One thing that strikes me is that this hasn't happened in the last two decades of China's rise. Okay, you could say, that's because the Chinese people were bought off with goodies. However, that's only part of the story. What's missed, as an article in FT points out, is that the Chinese state has shown itself highly competent, able to adapt and responsive to popular aspirations. In short, it does everything that a democratic government is expected to do- except that many democracies, including the US, are showing themselves to be increasingly dysfunctional.The author writes:

There is a tendency to see Chinese government as unchanging. This is because in the west the only reforms that we really count are those that appear to move the country towards the western model. In fact, government has been through huge and constant reform since 1978, far greater than anything that has taken place in the US or the UK. It is inconceivable that the Chinese state could have masterminded such a huge economic transformation if it too had not been the subject of profound reform. This process will continue, probably even more dramatically.

The Chinese communist party is seen as monolithic and intolerant. In fact, it contains within itself diversity of views and there is no reason to suppose that tolerance of dissent is a great deal less than in western democracies (where views outside a certain mainstream can be filtered out quickly or even actively suppressed). Voters in the US may have a theoretical choice between two parties but, on a wide range of issues, you have to think very hard to tell the difference between George Bush and Barrack Obama. This applies to the UK and many other democracies as well. The choices open to voters are within a rather narrow bandwidth.

The odds are that, instead of China going into decline because of its one-party system, it is the west that may suffer decline the years to come:

The west is in decline, Europe rampantly so. Some estimates suggest that by 2030 China could account for a third of global output and be twice the size of the US economy. American power would then be a pale shadow of what it is today. This is bound to affect how the American people regard their political elite and political system. Furthermore, with strong evidence that living standards have been static for many people in the US and western Europe, the outlook is uncertain.

Gloomy views of China go hand in hand with western attempts to undermine the Chinese system in many ways, as an article in Atimes points out. These attempts take various forms: support for separatist groups, talk of the high level of corruption in China, criticism of crackdown on dissidents and a constant glorification of western cultural and political values:

The hierarchy of China experts is this: At the top we find the philosophers and statesmen who set the stage and agenda for the universal ideology - exclusively serving Western interests. They always reside in the West, know little or nothing about China, and discuss China solely on Western terms......Next we have the journalists and editors, most of them white or accessory white, in key positions at the New York Times, Wall Street Journal, Economist, and so on. Thanks to the Western planetary media monopoly, they have become the new global fascist elite.....They also prominently decide who - Chinese or foreigner- gets praised and who gets defamed, and - most importantly- what gets omitted in their China reports. Their own corrupt ways get omitted. Ask yourself, when was the last time you read a piece by a prominent Chinese (other than a dissident) in your nation's newspaper? You haven't. It is a tight Orwellian grip. 

It's not just China that is at the receiving end of western propaganda. Today, even greater venom is directed at Russia. 
 

RBI autonomy

What exactly is RBI autonomy in monetary policy? Does it set the policy objective (say, primary focus on inflation), the inflation target as well as the means to achieve the target? Are all these the province of the RBI? Or does the government have a say in these matters?

I would think that the government has the right to decide the primary objective and also the inflation target. When it comes to the means of achieving the objective, the decision is primarily that of the RBI but the government should be involved in decision-making.

That is how RBI governors have viewed matters all these years. They have ensured that the government is duly consulted on monetary policy matters and then taken the final call on interest rates. Over the past year, however, the RBI has sought to change the situation somewhat. The Urjit Patel committee recommended that inflation targeting would be the primary objective and it also set the inflation targets to be met. The interest rate policy to meet the targets has also been decided by the RBI. It does seem that there is over-reach on the part of RBI.

Now, moves are afoot in  government to get the balance right between itself and the RBI. The government wants to set the inflation target. Monetary policy will be decided by a committee dominated by outsiders. This amounts to a dilution of the RBI's autonomy as it takes away the RBI governor's right to be the final authority on interest rates. I guess the government's moves were inevitable given the attempt on the part of the RBI to be the sole decision-maker in monetary policy matters.

More in my article in the Hindu, The limits to autonomy.

Travails of entrepreneurship

The business media tends to romanticise entrepreneurship by focusing on the success stories, says Schumpeter in the Economist. I would add that it also tends to portray entrepreneurs as people who know how to balance work, leisure and family, have great EQ and, of course, they glorify the millions that entrepreneurs make.

The reality is that entrepreneurship is enormously challenging mentally and physically. Schumpeter writes:

Business professors celebrate the geniuses who break the rules and change the world. Politicians praise them as wealth creators. Glossy magazines drool over Richard Branson’s villa on Lake Como. But the reality can be as romantic as chewing glass: first-time founders have the job security of zero-hour contract workers, the money worries of chronic gamblers and the social life of hermits.

Failure rates are frighteningly high:

Over half of American startups are gone within five years. Most of the survivors barely stumble along. Shikhar Ghosh of Harvard Business School (HBS) found that three-quarters of startups backed by venture capital—the crème de la crème—failed to return the capital invested in them, let alone generate a positive return. In 2000 Barton Hamilton of Washington University in St Louis compared the income distributions of American employees and entrepreneurs, and concluded that the latter earned 35% less over a ten-year period than those in paid jobs.

As for their being balanced personalities, forget it:

John Gartner, who teaches psychiatry at Johns Hopkins University medical school, suggests that a disproportionate number of entrepreneurs may suffer from hypomania, a psychological state characterised by energy and self-confidence but also restlessness and risk-taking. Numerous studies confirm, at the least, that they are prone to over-optimism.

Schumpeter quotes one ex-entrepreneur as urging would be entrepreneurs to have more healthy lifestyles. Somebody else urges them to get support networks and mentors.

I doubt that these can help. Entrepreneurship is a passion. Like great works or art, music or even writing, they are born of enormous sacrifice. Sometimes there are rewards at the end of the tunnel, very often there are none. Entrepreneurship is a form of madness. Entrepreneurs will pursue their dreams regardless. To ask them to do so in a balanced way or with help or guidance is rob them of the special quality that makes for success in some cases.

You cannot ask an entrepreneur to be balanced any more than you can ask a genius or a prodigy to be normal.

Is optimism about India's growth prospects justified?

Analysts see an acceleration in growth to 5.5%. 6.5% and 7% starting this year and then in the next two years. Is this feasible? I think yes. But the RBI needs to help out by cutting the interest rate.

My analysis appears in today's Asian Age, Growing Pains.

When management gurus dissect politics....

How can we tell whether a political leader such as Narendra Modi will succeed? Three management experts, including Ram Charan, attempt an answer in a business journal. I can't say I was bowled over by their analysis.

The authors say we should look for five signals, on all of which Modi scores. Let me take up two in detail

i. How deep is the politician's insight into public interest? Modi's interest is very deep, the authors say, because of his own background of poverty. Well, Manmohan Singh too came from a poor family in a very backward village. He could, perhaps, claim that he understood the poor as well as the elite and was thus well placed to negotiate his way through the elite on behalf of the poor.In India (unlike in the US), we have hordes of politicians who have come up from the grassroots. Lalu Yadav and Mayawati, for instance. But they have not proved to be transformative leaders in the sense of bringing about an improvement in the lives of the class of people they once belonged to.

ii. Can the leader get things done? Modi has a record as a doer in Gujarat, the authors point out. But Gujarat was one of the best performing states even before Modi became Chief Minister (although, to his credit, Modi was able to maintain that record). India's growth rate has improved since the nineties and through the noughties under a succession of governments and leaders. Not all were headed by doers. However, starting with Narasimha Rao, we managed to put in place policies that paid off. So, yes, it helps to be good at execution but the role of policy must not be understated.

The authors mention other factors that favour Modi: his business mind-set, his ability to engage senior government officials, the broad support he enjoys. It's hard to disagree on these. But none of these by themselves or even put together ensure results.  Both Indira Gandhi and Rajiv Gandhi had broad support but both saw how quickly this could dissipate. A "businesss mind-set" can be a negative if it means being pro-business at the expense of welfarist considerations.

Modi's strengths are his ability to connect with the masses, formidable administrative experience, a a capacity to think out of the box. deep study and reflection, boundless energy and a genuine passion to make a difference at the national level. This combination bodes well for any leader. We don't need management experts to tell us that.